The difference between equity and stock is that while all stock is a type of equity, there are several types of equity that are not stock. Equity in a business consists of everything the owners have invested plus any earnings the company retains. Common and preferred stocks are just one way that owners can establish an equity stake in a company.
TL;DR (Too Long; Didn't Read)
Equity and stock are not two separate creatures. Stock is equity, but equity includes other things.
Equity vs. Stock
Equity is the owners' stake in the business. On the balance sheet, it's what's left after you subtract company liabilities from the value of company assets. Analysts compare the amount of equity and the amount of debt to figure a company's strength. Corporate equity includes:
- Common stock. This gives you an ownership stake in the company. You have a vote in how the company is governed unless you own nonvoting stock. If the company issues a dividend out of its annual profits, you receive some of the money.
- Preferred stock. If earnings are low, preferred stockholders get paid ahead of the common stockholders.
- Retained earnings. If the company has, say, $1.1 million in net income, it can issue that as dividends to stockholders or keep it for future needs. The amount retained is another form of equity.
- Contributed surplus. Corporations often issue stock with a par value of, say, 10 cents or $1. If investors snap up the stock at a higher price, the excess is listed on the balance sheet as contributed surplus or additional paid-in capital.
- Treasury stock. This is stock the company has purchased back from the customers.
Share capital is another name for the money invested by the company's stockholders. It's also called equity capital or paid-in capital. The difference between equity and share capital is that share capital doesn't include retained earnings, while equity does.
Equity and Partnerships
In a corporation, most non-stock equity is in the form of retained earnings. If the company is a partnership or a sole proprietorship, the owners' stake in the business is still equity, but it doesn't involve stock.
For example, suppose two landscapers join forces in a partnership. Each partner has equity in the business, representing his investment and contributions. That equity entitles them to a share of the profits and a say in running the company.
Partnership equity can be complicated. A 50-50 partnership could involve one partner investing more money, while the other provides superior skills and commits more time. A well-written partnership agreement can make it clear how this works and how it affects the division of the company's profits.
Equity and Sole Proprietorship
Like partners, sole proprietors have equity in their business but not in stock form. Equity consists of whatever capital they invest in the company.
If, for instance, you put $10,000 into your new business when you start it up, that's your total equity. Any assets you buy with the money remain part of your equity. Over time, though, equity will probably change when:
- You withdraw money to support yourself.
- You invest more money in the business.
- You suffer a loss that reduces your capital investment.
- You turn a profit and keep the money in the company, like retained earnings.
Equity and Bankruptcy
Even though equity and stock both represent an ownership stake in the business, it's possible you won't be able to collect if the business closes. In a partnership or sole proprietorship, you have to pay off all your business debts, so everything you invest is at risk. If that's less than your debts, your creditors can come after your personal assets as well.
In the event of a corporate bankruptcy, stockholders don't have to worry about losing more than they invest. However, their equity stake is vulnerable. Owners are at the end of the line to get paid after vendors and lenders. Even if the company emerges from bankruptcy, your shares may end up worthless.
- AccountingTools: Equity Definition
- Corporate Finance Institute: Equity Accounts
- FindLaw: Does Partner Equity Require Equal Cash Contributions?
- Corporate Finance Institute: Share Capital
- Business Plan Hut: Equity of Proprietors, Partnerships and Corporations on the Balance Sheet
- Fundera: Sole Proprietorships: What You Need to Know to Get Started
- Finra: What a Corporate Bankruptcy Means for Shareholders
Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com